1) If a firm adopts a residual distribution policy, distributions are determined as a
residual after funding the capital budget. Therefore, the better the firm’s investment
opportunities, the lower its payout ratio should be.
2) The retained earnings account on the balance sheet does not represent cash. Rather, it
represents part of stockholders’ claims against the firm’s existing assets. This implies
that retained earnings are in fact stockholders’ reinvested earnings.
3) Normal Projects S and L have the same NPV when the discount rate is zero.
However, Project S’s cash flows come in faster than those of L. Therefore, we know
that at any discount rate greater than zero, L will have the higher NPV.
4) The twin goals of inventory management are (1) to ensure that the inventories needed
to sustain operations are available, but (2) to hold the costs of ordering and carrying
inventories to the lowest possible level.
5) Sinking funds are devices used to force companies to retire bonds on a scheduled
basis prior to their maturity. Many bond indentures allow the company to acquire bonds
for a sinking fund by either purchasing bonds in the market or selecting the bonds to be
acquired by a lottery administered by the trustee through a call at face value.
6) The United States and most other major industrialized nations currently operate
under a system of floating exchange rates.
7) If a firm’s stockholders are given the preemptive right, this means that stockholders
have the right to call for a meeting to vote to replace the management. Without the
preemptive right, dissident stockholders would have to seek a change in management
through a proxy fight.
8) A project’s IRR is independent of the firm’s cost of capital. In other words, a project’s
IRR doesn’t change with a change in the firm’s cost of capital.
9) Shorter-term cash budgetssay a daily cash budget for the next monthare generally
used for actual cash control while longer-term cash budgetssay monthly cash budgets
for the next yearare generally used for planning purposes.
10) If a firm’s goal is to maximize its earnings per share, this is the best way to
maximize the price of the common stock and thus shareholders’ wealth.